“Art of the Deal”

There is no part of the world left untouched by the “art of the deal.”  Look no further than the United Kingdom whose Prime Minister Theresa May announced this week that her Cabinet agreed to a plan to exit the European Union in March 2019 (opening the door for Parliament approval) only to see many senior members of her team (including Brexit Minister Dominic Raab) resign.  It seems that the United States has no monopoly on political divisions and the difficulty for elected officials to govern through compromise.  Instead, some Members of Parliament (roughly 20 out of 650 members) are calling for a vote of “no confidence” in the PM elected to see this difficult task through.  It requires 48 MPs to call a vote on May’s leadership.  The European Union, knowing the instability that exists in the UK political landscape, remains relatively silent hopeful that the process will work out.

Hope, unfortunately, is not a strategy.  Preparation is, but it is difficult to prepare for what happens in a “no deal” Brexit which is possible.  After all, it requires unanimous vote to extend the March 2019 deadline and in today’s age it is hard to imagine getting unanimous agreement on anything all the way down to what snack to have at tea.  No deal means no period of transition – no time to work out the kinks.  Trade rules would revert to WTO standards which makes each subject to tariffs and other previously removed roadblocks to commerce.  The status and right to work for UK and EU citizens living in the other’s territory is thrown into question.  Customs and other border issues would need to be addressed instantly impacting shipping, trucking (between England and Ireland), and flights.  In short, confusion and uncertainty – which neither economies nor financial markets embrace.  Instead of supporting economic growth, the uncertainty is more likely to cause a contraction of the economic output on both sides of the English Channel.

The exchange rates are a barometer.  Despite all of the concern in the US of policy mistakes, trade wars with China, rising deficits and government debt levels, and the ongoing political divide, the US Dollar continues to appreciate relative to the British Pound (GBP) and the Euro (EUR).  The GBP/USD exchange rate remains near its post-Brexit low at 1.28 GBP/USD – still 12% below the just pre-Brexit referendum level around 1.44 and nearly 40% below the peak of 2.11 just before the Global Financial Crisis.   The EUR/USD exchange rate rests now at 1.14 EUR/USD which is 9% below the 1.25 level when optimism reigned in January 2018 and almost 30% below its peak near 1.60 before the Crisis.

While we are not currency traders (and charts from those that are suggest there is still room for the GBP and EUR to fall further), there seems to be a good bit of pessimism priced in.  A November 25th summit with the EU is the next major milestone in the process followed by a December vote in Parliament (assuming May is not successfully challenged for leadership).  It will take all of the art the UK leadership has to complete the deal.